Honeywell’s CEO on How He Avoided Layoffs

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When Cote arrived at Honeywell, in 2002, the company had gone through three CEOs in four years. It had repeatedly missed earnings, and it had environmental liabilities that had never been dealt with. Virtually no pipeline of new products existed, because managers had been disinvesting to boost profits. Over the next five years he worked to fix many of those problems, and by the end of 2007 the company’s credibility had been reestablished with investors and its share price had more than doubled. Then the recession hit.

Cote’s view was that any restructuring Honeywell did in response should be what was best for business efficiency and profitability over the long term—not solely a reaction to the recession—and should have no impact on the company’s ability to outperform in recovery. The leadership team settled on furloughs, and this is the story of how they worked.

Photography: Getty Images

The Idea: When the Great Recession hit, many companies “restructured” and laid off thousands of workers. By asking employees to take unpaid leaves instead, Honeywell positioned itself for the recovery.

When I arrived at Honeywell, in 2002, the company had gone through a challenging period. In 1999 it merged with AlliedSignal and shortly afterward closed on the acquisition of a company called Pittway. The three cultures were never integrated, Honeywell had repeatedly missed earnings, and the company had announced cumulative write-offs of $8 billion. Having been in the chemical industry for more than 100 years, it had environmental liabilities that had never been dealt with. Honeywell had gone through three CEOs in four years and had had a lot of turnover at the managerial level as well. Virtually no pipeline of new products existed, because managers had been disinvesting to boost profits.

In my first five years here, we worked to fix many of those problems. We instituted more-conservative bookkeeping and addressed our environmental liabilities. We invested in new products and services, and we expanded abroad. The share of our revenue coming from outside the United States increased from 41% in 2002 to 54% in 2012. We built our management bench strength to the point where 85% to 90% of our top-level vacancies are filled by internal candidates; previously only 50% had been. Most important, we established a “One Honeywell” culture in which we focus on business acumen, listening to the customer, and doing what we say we’re going to do. By the end of 2007 we had reestablished our credibility with investors, our share price had more than doubled, and we were significantly outperforming the S&P 500 and our peer group averages.

In September 2008, though, we began to see a shift in our business. Suddenly orders were being canceled, and no new ones were being placed. It soon became obvious that the U.S. was in a recession and that we, as a big industrial company, were going to see our results soften. The only businesses in our portfolio that held up well were defense, aerospace, and energy efficiency. Everything else was down.

Businesses like ours have two primary costs: the material we use to make products, and people. In a recession, material costs (direct costs) drop naturally—you just buy less stuff as your incoming orders decline. You can also work around the edges by seeking opportunities to lower indirect costs such as travel and other non-business-critical expenses. Cutting the costs of people, which in an industrial company usually account for 30% to 40% of total costs, is more difficult. Companies typically react by “restructuring”: They cut, say, 10% of the workforce, take a big charge against earnings, and move on. We did do some restructuring in 2008–2009, but I’ve never been fond of that approach to a recession. So we made sure that any restructuring we agreed to during that period would be permanent—in other words, not solely in response to the recession but, rather, what was best for business efficiency and profitability over the long term—and would have no impact on our ability to outperform in recovery.

As my leadership team began looking at options, we kept coming back to the idea of furloughs: Workers take unpaid leaves but remain employed. The conventional wisdom is that because furloughs spread the pain across the entire workforce, they hurt everyone’s morale, loyalty, and retention, so you’d do better to lay off a smaller number, focusing on weak performers. They’re also a challenge logistically. To implement them, we needed to comply with individual state laws and also laws in other countries where we do business. The process didn’t go perfectly. Looking back, I recognize some clear mistakes we made, and if I had to do it again, I’d do a few things differently. But on the whole, our decision to use furloughs rather than layoffs was a success.

Why Layoffs Replaced Furloughs

Peter Cappelli is the George W. Taylor Professor of Management at The Wharton School and the author of Why Good People Can’t Get Jobs: The Skills Gap and What Companies Can Do About It (Wharton Digital Press, 2012). He spoke with HBR about why furloughs have become unusual.

Historically, most companies used furloughs to reduce payroll costs during recessions. When did layoffs replace furloughs?

More recently than you might think. Until 1985 the U.S. Bureau of Labor Statistics didn’t even have a category for permanent job loss. Until then the assumption was that if a company laid you off, it would rehire you when the economy picked up. That changed during the 1981–1982 recession. Companies had become bloated with managers during the slow growth of the 1970s, as talent management practices failed. Since then the risks of losing a job as a manager have been greater than the risks facing blue-collar workers.

Do managers tend to underestimate the costs of layoffs?

Yes. Most organizations have almost no idea of their turnover costs, their hiring costs, or the costs of keeping a job vacant. They do know what it costs when someone is in the job—the amount they’re paying that person—so they know how much they’ll save if they get rid of him or her. That’s one of the big problems in talent management: CFOs can give us labor costs to the penny, but they can’t measure the value of employee contributions, which creates a bias toward cutting.

Since the 1990s Wall Street has reacted positively to layoff announcements. Are there any signs that attitude is changing?

Researchers have begun looking at that question lately. It’s true that companies don’t see big payoffs (in stock price) from layoff announcements anymore. One theory is that the investment community has gotten smarter and knows that layoffs often aren’t worth the costs. The other is that investors have realized that companies making big layoff announcements often fail to follow through with all the job cuts. We’re not sure which theory is correct.

Source: Challenger, Gray & Christmas

The False Promise of Layoffs

When I arrived at the company, I thought we had too many people. Over the next five years we managed to keep employee numbers flat—even as sales increased at a compound annual growth rate of 10%—and we eliminated some lower-performing employees by doing more-rigorous performance reviews and not filling jobs that were vacated through normal attrition. When the recession hit, our head count still wasn’t as low as it could have been, so if we did layoffs, we wouldn’t be “cutting into bone.” But we opted for furloughs, for several reasons. Most managers underestimate how much disruption layoffs create; they consume everyone in the organization for at least a year. Managers also typically overestimate the savings they will achieve and fail to understand that even bad recessions usually end more quickly than people expect. We wanted to be ready for recovery as soon as it came, whether it was soft or V-shaped, and furloughs were one way of positioning us for any outcome.

To understand that reasoning, look at what really happens when you do layoffs. Each person laid off gets, on average, about six months’ worth of severance pay and outplacement services. So in essence, it takes six months to start saving money. Recessions usually last 12 to 18 months, after which demand picks up, so it’s pretty common for a company to have to start hiring people about a year or so after its big layoff, undoing the savings it began realizing just six months earlier. Think for a minute about the costs of a layoff the way you’d think about a traditional investment in a plant or equipment. Imagine going to your boss and saying, “I want to spend $10 million on a new factory. It will take us six months to break even on it, and then we’ll get to run the factory for six months. But at that point we’re going to need to shut it down.” You’d never do that—yet when it comes to restructuring costs to lay off employees, everyone seems to think it makes sense.

That’s because when faced with a recession, managers find it hard to look ahead toward recovery. If you worry that a recession is going to last forever, you may believe that the savings achieved by a layoff will be permanent. But that’s not really how it works. I’ve been a leader during three recessions, and I’ve never heard a management team talk about how the choices they make during a downturn will affect performance during the recovery. But in 2008 and 2009 I kept reiterating that point: There will be a recovery, and we need to be prepared for it.

Both layoffs and furloughs can create behavioral issues and costs, and you could argue that furloughs are tougher in some ways. But one fact remains: Layoffs are much more disruptive to an organization in both the short and the long term. Even employees who stay are extremely distracted, because they’ve lost friends and are worried about their own jobs. To me, that’s no way to run a railroad.

The Challenges of Furloughs

We told our businesses to ask every worker to take a series of unpaid weeks off during the first half of 2009. The number of weeks varied by business—the average furlough was three to five weeks, taken in one-week blocks—and business leaders reassessed their situations every few weeks to see if additional furloughs were necessary. This approach presented its own difficulties. Some states have very strict laws about what constitutes work, so we sometimes had to take away people’s smartphones and laptops to ensure that they didn’t check office e-mail during a furlough. In some foreign countries, government regulations and approvals prevented us from doing furloughs at all. But in most places the program went pretty smoothly, at least in the beginning. During the first week or two we received positive feedback: People felt good about making sacrifices, because they knew they were helping to save jobs—maybe their own, maybe a colleague’s. As the furloughs kept going, however, their attitude began to change. Some people complained, “I can’t live on this salary.” Some concluded that they wouldn’t have been among the people laid off, so they started to resent the sacrifice.

We also faced challenges when our top executives—my direct reports—felt that they, too, should be furloughed, as a symbolic gesture. To me this was mistaken solidarity and shortsighted. I told them we couldn’t afford to have leaders absent during this period. I also reminded them (and our employees) that as leaders, they received more than half their annual compensation in the form of a bonus, so although employees were losing five weeks’ pay, on average, leaders would be losing far more. “Trust me—on a percentage basis, you’re going to be severely affected,” I told them. The bottom line was that we needed them to stay at work.

The rap on furloughs is that they penalize top performers and cause them to leave. But our “regrettable turnover” decreased significantly.

By the summer of 2009 people were pretty anxious. They wanted to know how many more weeks of furloughs might be necessary. We still didn’t consider layoffs, but we did begin looking at benefits costs, to see if we could find ways to save more money without putting people out of work. I tried to explain to everyone—both employees and my top executives—that we had three constituencies whose interests we needed to balance: customers, investors, and employees. Penalizing customers wasn’t an option, and product programs had to go forward. So the pain would have to be divided between investors (in the form of lower returns) and employees (in the form of reduced pay). Finding the right balance was a challenge, but I think we accomplished that.

Prepared for Recovery

The economy stayed soft for most of 2009. During the first nine months of the year, our unit leaders had difficulty making their sales forecasts because demand kept weakening. However, despite lower sales in 2008–2009, the company stayed highly profitable and held its segment margin rates, which is very difficult to do in a recession.

During the fourth quarter of 2009 our sales forecasts stopped going down, and by January of 2010 my team and I were starting to talk about a recovery. As orders began to pick up, it was clear that we were well prepared in comparison with our competitors: Our inventory and delivery times were better, and because we had held on to our people, we found it easier to win new business.

Honeywell International Facts & Financials

Founded: 1885Headquarters: Morristown, New JerseyEmployees: 132,000

Source: Honeywell

We watched our turnover very carefully as the economy rallied. The rap on furloughs is that they penalize top performers and cause them to leave. But in fact our “regrettable turnover” (the number of employees we’d like to retain who nevertheless choose to leave) decreased significantly. That makes sense to me. Generally speaking, not everything is about money: People aren’t mercenary, and they want to be part of something successful that is bigger than themselves. We’d had a good track record since 2002, we had a lot of employees who believed in what we were doing, and we communicated it clearly. People could see that things wouldn’t stay awful forever, so they hung in.

Even so, I believe that we made two mistakes in implementing our furlough program. The first was how we let employees know about the sacrifices I would be making. Very early in the recession I decided that I would not take a bonus for 2009. At the time, my annual bonus was around $4 million, so that was significant. When employees asked me in town hall meetings how the recession would affect my compensation, I always gave the politic corporate governance response: “That’s not my decision—it’s up to the board.” Everyone would have been better served if I’d just said that I’d already decided to forgo my bonus.

The second mistake was that when we decided to let individual units determine how many weeks of furlough they needed, we should have made it clear that we didn’t want them imposing standardized furloughs across their businesses. For example, some of our units furloughed workers in China, where revenue was still growing. Employees in emerging markets have a lot of opportunities, and ordering furloughs in a fast-growing market created some HR problems and organizational angst that we could have avoided.

Still, I believe that our decision to use furloughs instead of layoffs was the right one and that we managed to get about 90% of the implementation right. I hope we never have to do it again—but if we do, I’ll make sure we hit 100%.

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